Croatian National Bank Foreword
Following a deep and protracted recession after the great financial crisis, the Croatian economy has markedly improved over the last couple of years against the background of EU accession. Exports grew strongly as the remaining barriers to trade were dismantled and boosted competitiveness, with strong increases both in exports of goods, as well as exports of services, on the back of steadily increasing numbers of foreign tourists and their rising consumption.
Stronger absorption of EU funds boosted public and private investments and facilitated further upgrades of local infrastructure. Accordingly, the current and capital accounts remained in ample surplus since 2014, facilitating strong deleveraging of domestic sectors with foreign indebtedness following a steady downward path. Propped up by favourable developments, most previously accumulated macroeconomic imbalances decreased significantly. The unemployment rate fell to an all-time low, the fiscal balance turned positive in 2017, and the public debt-to-GDP ratio gradually decreased. All these improvements were reflected in the lower risk premium for Croatian public debt, which improved financing conditions.
Without underestimating this unprecedented shock and the negative short and medium-term impact it will cause, Croatia is currently in a much better position to face this challenge than was the case several years ago. The public debt-to-GDP ratio has been on a downward path for five consecutive years and the general government balance was positive for the past three years. The balance of payments is in surplus and the external position much more robust. The somewhat smaller degree of integration in the EU-wide value chains in comparison to other Central and Eastern European countries will dampen the effect of reduced demand from the main trade partners (notably Italy and Germany). All this creates substantial policy space for both monetary and fiscal authorities, which have deployed their policy packages in a timely way with the onset of the crisis, in order to preserve the liquidity and solvency of the corporate sector and dampen the shock to household incomes. However, large reliance on tourism may somewhat exacerbate vulnerabilities in the very short term, but Croatia has a comparative advantage in this sector and will no doubt continue to reap major economic benefits from it in the future.
Developments in early 2020 conform to a more favourable picture, as available high frequency data for the first quarter suggests that economic activity contracted only slightly compared to the previous quarter, with the annual growth rate remaining in positive territory. Adverse data readings mirror developments at the very end of the quarter, driven by the containment measures aimed at fighting the novel coronavirus pandemic. High frequency data point in particular to a significant drop in retail trade and industrial production. Business confidence also worsened in all activities, notably in services. Unemployment increased when compared to the February level. The pandemic will result in significant contraction of real GDP for the entire 2020.
Overall real activity is forecasted to contract by around 9% in 2020 in the baseline scenario, but large uncertainties continue to linger. The extent of the damage to the economy will depend on the pace of lifting the restrictive containment measures (lockdown) and the resumption of normal activity, a possible pick-up in the number of domestic infections, a recovery path in the euro area and, linked to it, domestic tourism prospects. At the moment, it seems that the recovery will most likely be only gradual.
From a broader perspective, recovery from this crisis, investment opportunities and expansion, as well as gains in Croatia’s real convergence, will depend on external demand but, more importantly, on the country’s dedication to continue reforming its institutional set-up, business and investment climate, and education system. The country’s commitment to reforms is visible and welcome. Croatia’s Doing Business ranking improved in 2019, the country made significant progress in its attempt to enter ERM II, while membership of the Schengen Area is still among the top political and economic goals. Croatia is on the right path, but has to run faster if it wants to catch up with achievements of its CEE peers.
Croatian National Bank
Zagreb, May 2020